New way to help mortgage market

July 28, 2008 12:12:36 PM PDT

By MARTIN CRUTSINGER AP Economics Writer

WASHINGTON (AP) - July 28, 2008 --

The Bush administration and federal banking regulators joined with the nation's four largest banks Monday to endorse a new way to pump money into the battered U.S. mortgage market. Treasury Secretary Henry Paulson unveiled a set of best practices designed to encourage banks to issue a debt instrument known as a covered bond. The administration hopes these bonds will replace some of the mortgage financing that has disappeared as investors have incurred billions of dollars of losses on mortgage-backed securities.

"As we are all aware, the availability of affordable mortgage financing is essential to turning the corner on the current housing correction," Paulson said in launching the new effort.

"We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing," he said.

Paulson was joined at the news conference by officials from the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision. All the agencies said they endorsed the new set of best practices compiled by Treasury.

Private analysts said that the new initiative should help stabilize the U.S. mortgage market but they did not view the effort as a cure-all for all the problems facing the mortgage market now.

This effort to jump-start a U.S. market for covered bonds followed action earlier this month by the FDIC to approve new regulations for the bonds, which are a way of packaging mortgage investments similar to an approach that is used in Europe where the market for covered bonds approaches $3 trillion.

Covered bonds are issued by banks and backed by cash flows from mortgages or other types of debt. Under this approach, banks guarantee the bonds, thus providing an incentive for less risky lending practices. Unlike mortgage backed securities, covered bonds remain on the balance sheet of the bank that sells the bonds.

Encouraging such a market to grow could be one way to decrease the dominance that Fannie Mae and Freddie Mac wield in the U.S. mortgage market.